I have been a CPA for over 30 years focusing on taxation. I have extensive experience with partnerships, real estate and high net worth individuals.
My ideology can be summarized at least metaphorically by this quote:
"I have a total irreverence for anything connected with society except that which makes the roads safer, the beer stronger, the food cheaper and the old men and old women warmer in the winter and happier in the summer." - Brendan Behan
Nobody I work for has any responsibility for what goes into this blog and you should make no inference that they approve of it or even have read it.

Avoiding Excess Credit Card Interest Should Not Be A Taxable Event

Michael and Sharon Bross stood up to a credit card company that, as they saw it, overcharged them. The company backed down. I think people who do that deserve a medal. The IRS thinks they should be taxed. Sadly, the Tax Court agreed with the IRS. They call it cancellation of indebtedness income (COI). I call it unfair.

I understand why, in general, cancellation of indebtedness needs to be included in gross income. In a lot of situations,having indebtedness cancelled is equivalent to receiving money. A lot of times it strikes me as kicking somebody when they are down, but that is an emotional response. I really think that the stand that the Tax Court takes on discharges of credit card interest is wrong. My view is that talking a credit card company out of screwing you should not be a taxable event. Here is some of the story:

Before the year in issue petitioners intended to take advantage of a deferred interest financing arrangement offered by a credit card company in connection with the purchase of furniture from a certain furniture store (financing arrangement). In effect, the financing arrangement allowed for no interest to accrue on certain furniture purchases financed through charges to a credit card issued to petitioner by a certain credit card company if the charges were completely paid by certain specified dates. If the charges were not completely paid by the specified dates, then interest would be charged to the credit card account in an amount computed from the date of purchase.

I’ve made purchases like that myself and have always regretted it. It is not that they caught me being slightly late and charged me a ton of back interest. It is that I found the prospect so nerve wracking that I paid the thing off much earlier than I should have. Of course since money doesn’t really earn interest anymore, it doesn’t bother me that much.Petitioners misinterpreted the terms of the financing arrangement, and petitioner was charged interest that petitioners believed he did not owe. Petitioners unsuccessfully attempted to resolve the dispute with the credit card company over an extended period during which additional interest and late payment penalties added to the amount the credit card company claimed that petitioner owed. All of the interest and late payment penalties charged to the credit card account were consistent with the terms of the credit card agreement entered into between petitioner and the credit card company pursuant to the financing arrangement.

The Tax Court kind of held it against Mr. Bross that he was an attorney. Mrs. Bross is a real estate agent. I guess the idea is that they should have known better than to listen to the furniture salesman who explained the deal and read the fine print for themeselves.As it turned out, during 2007 petitioner reached an agreement with the credit card company. As part of that agreement and in return for a partial payment, the credit card company canceled the unpaid balance of the credit card account. In due course, the credit card company issued to petitioner a Form 1099-C, Cancellation of Debt, showing $3,214.28 as the amount of debt canceled.

We begin by noting that petitioners’ claim that the credit card company misrepresented the terms of the financing arrangement is not supported by the record. Petitioner agreed to the terms of the financing arrangement at the time of the furniture purchases. Furthermore, the terms of the financing arrangement were also included in the monthly credit card statements generated by the credit card company. At most, petitioners, although both highly educated professionals, misunderstood those terms.

This is one of the reasons, I am not a Tax Court judge. In my mind, if there is a credit card company involved, there should be a presumption that financing arrangements are being misrepresented.Under the circumstances, petitioner’s claim that he was not liable for the portion of the credit card debt ultimately discharged did not render that debt a “contested liability” within the meaning of the above-referenced authorities.

All kidding aside, this is the reasoning of the Tax Court in this, and similar cases, that I just don’t get. How was this not a contested liabilities ? The taxpayer argued with the credit card company and the credit card company gave in. Given that it was interest that was forgiven, I don’t really see that the taxapayers had an accretion of wealth from the transactions. They just avoided getting screwed. Avoiding getting screwed should not be a taxable event.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

The Tax Court is correct. It is not the settlement of a disputed liability. You may not agree with the liability, but it was legally enforceable. We have 1099 C cases for forgiveness of mortgage debt which we conrest because it truly is settlement of a bona fide dispute.

I’m not sure if ‘hilton’ is only speaking of Mortgage Debt when contested in Civil Court between the Mortgagor and Mortgagee or if ‘hilton’ is talking about contesting the forgiveness of the mortgage debt and the tax consequences disputed between Commissioner and Taxpayer. I don’t know the basis for contesting debt in Civil court between two private parties because I am not an attorney and I am also sure it would probably change based on state – but I do wish to address the second situation. In the latter case, the the biggest reason the Cancelled Debt is considered non-taxable is because it’s generally a principal residence and it simply reduces the ‘principal residency exclusion’ in future years when the residence is finally sold (unless put into service as rental in which case the situation is more annoying then we ought to get into here). This is why the basis of the principal residence is reduced by the forgiven debt. In the case of insolvency then the forgiven debt also reduces basis in the property and tax consequences are merely delayed till the future when the house or property is sold and gain is recognized in proportion to the amount of forgiven debt. In both of those situations the Tax Court and the Commissioner is not concerned in the least with whether or not the debt was truly an enforceable liability (although they most definitely are if you are on the other side of the fence and the taxpayer issuing the 1099-C). Additionally, if debt is to be called into question it must be done in a court between both the one borrowing and the one lending. In other words, it isn’t the IRS’s problem what two private parties work out as debt owed or what a separate court decides. What matter’s is that they get the revenue dollars taxed either on the side of the fence that is earning the interest or the side of the fence that should have been paying the interest.

I’m not sure I fully get your analysis of the interaction between section 108 and residence exclusion. You lost me a little on that one. In this case there was non-deudctible credit card interest that was being disputed. If the interest being disputed was trade or business interest, the whole thing would have been a wash.

Right – so with credit card interest the situation is a bit different. I went through the long winded statement concerning a mortgage type loan because the initial commentor appeared to think that the basis for contesting the validity of the loan mattered to the IRS. My point is that the IRS doesn’t care and shouldn’t care (unless given other situations) because that would call for a different court case altogether. Ultimately they collect tax on the mortgage type forgiveness too because it eats away at the basis of the property. Now whether or not that reduction in basis will matter depends on whether or not the house is a principal residence because chances are if it is a principal residence the gain will be excluded. I guess my point is that there is no free lunch as far as the IRS is concerned. Every dollar you get in some way is taxed either now or in the future. You don’t just get away with a 1099-C. I agree with the trade or business interest statement that you made above and I’m only talking about personal property. After thinking about this whole 1099-C mess I’m thinking I’d better go do some more CPE in this area!

The taxpayer is not getting screwed. They signed a contract and did not follow through. Why should they get something for nothing just because they claim ignorance and don’t read the contract. They used the credit card’s money. These types of programs work fine if you pay your bills and take responsibility for your debt. It is this lack of responsibility that clogs our court system. Next time they buy something, why don’t they try saving their own money until they have enough to pay for what they want. Oh, that would mean they have to be responsible!

I refer you also to my above comment in response to ‘hilton.’ Which might help you understand what I’m about to say. This article reminds me of another article that was on here in the past concerning 1099-C’s and I had suggested that a whipsaw arguement might be used by Commissioner. Now I’m no lawyer (thank god!) but it would seem to me that a separate reason for a Tax Court to decide in favor of the Commissioner in the case of interest forgiveness is simply that the Commissioner has already lost tax dollars when the 1099-C was issued to the taxpayer and then used as documentation to support the bad-debt write-off expense on the debt holder’s side of the fence. If the debt is not an enforceable obligation then the Commissioner should take the debt holder to court. Again I’m not a lawyer but I believe that the whipsaw arguement generally comes up when the Commissioner could be stuck losing on two cases over the same issue and consequently losing tax dollars on both the expense recognition side of the fence (or debt holder) and then on the revenue recognition side of the fence (or the debtor). Looking forward to the comments to follow!

The 1099-C is not necessarily symmetrical with a bad debt write-off. A previous case concerned an organization that bought up credit card debt. The 1099-C would be for the face amount, but a bad debt write-off would be limited to their basis.

Good point – I guess that’s why you don’t see those cases. However this begs the question, how about the first company that originates the claim of debt writing them off after selling at an extreme discount to a collection agency?